In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). The purpose of this update was to remove all industry specific revenue recognition guidance and replace it with a single set of accounting principles addressing revenue recognition applicable for substantially all industries. As the construction industry has had significant industry specific revenue recognition guidance that is being replaced with ASU 2014-09, questions from financial statement users and companies arose regarding implementation. The AICPA established and charged the Engineering and Construction Contractors Revenue Recognition Task Force (the “Task Force”) to address implementation issues anticipated to affect construction contractors. The Task Force is in the process of addressing seven specific key issues, bulleted below. We have broken down the Task Force’s analysis of the first issue below and will follow with an article each month as we analyze the remainder of the Task Force’s findings and recommendations.
Seven Implementation Issues Identified:
- Identifying the Unit of Account (including combining contracts, loss of segmentation guidance, options, separate performance obligations).
- Variable Consideration / Estimation Method (including claims, change orders (unpriced and unapproved), incentives, penalties, extras, liquidated damages, back charges, collectability)
- Acceptable measures of progress (including when each measure is acceptable to use, Accounting for Service Contracts, Wasted Materials).
- Uninstalled materials
- Impact of Termination for Convenience on Contract Duration
- Contract Costs
Identifying the Unit of Account
The first issue identified by the task force relates to identifying the unit of account, including factors to consider when evaluating whether a single contract should be accounted for separately, or combined with similar contracts, and general guidance related to analyzing separate performance obligations.
The Task Force interpreted the generally accepting accounting principles related to identifying contracts with customers and supports that contracts should possibly be combined when there are separate contracts with the same customer, depending on the circumstances. For example, one contract for engineering services and one contract for construction services that are issued only a month apart (or near the same time), should likely be considered for reporting as one contract. In this example, if these two contracts are for the design and construction of a single capital asset, and when combined would result in a single performance obligation, these two contracts should be combined and reported on as one contract with one underlying performance obligation. The task force concluded that significant judgment and documentation will be required when developing accounting policies and interpreting contracts as additional facts or different circumstances may result in different conclusions.
Complete analysis and documentation of consideration given to identifying separate performance obligations will impact all construction contractors as the new revenue recognition guidance is analyzed and implemented. The Task Force noted that many factors come in to play; for example, what exactly one party owes the other and whether or not it is distinct. Each distinct good or service is accounted for as a performance obligation, the exception being if there is a series of goods that are substantially the same, they are also considered a singular performance obligation. Much of this information can be extrapolated from the terms of the contract and what the outcome or end of the contract is. Contractors should evaluate what exactly they are doing in the contract. If they are just providing one good or service, there is likely only one performance obligation and that is likely pretty clear, but if they are combining multiple inputs into a single output (as is the case in many construction projects), this likely supports there is only one performance obligation.
Most of the information needed to determine how recognition should occur can be found in the contract itself. Other factors that need to be considered are whether or not you take multiple assets and combine them to a single output, this would be a singular performance obligation as well. In other words, if there is any significant integration service, all separate parts performed should be accounted for together. Should the risk involved with the integration be inseparable from the risk of delivering the final output, or if the final output is likely to not be functional without the integration, then it should be considered significant and combined into one performance obligation. The guidance suggests that promised goods or services are not distinct if the contract is for services of integrating multiple components into one combined output. The guidance states that this is more of a risk-based judgement and should the risk of integrating the components be inseparable from the risk of transferring the final output, this would only count as one contract. Not every integration service has much risk involved, therefore it must also be evaluated as to the significance the service provides to the project. If the project would fail without a specific piece being integrated, then it is likely significant, and thus would count as a single performance obligation.
The details of the Task Force’s interpretation has been formalized and included in the current version of the AICPA Revenue Recognition Audit and Accounting Guide. Next month’s article will be a summary on their second issue analyzed, which is related to estimating the transaction price, including how to analyze variable consideration which includes claims, change orders, penalties, liquidated damages, and more.
For more information or to discuss how implementation is expected to impact your Company, please contact Nick Bilotta, Senior Audit Manager, and stay tuned for our future articles.